9 INTANGIBLE ASSETS
PERSPECTIVE AND ISSUES
Long-lived assets are those that will provide economic benefits to an enterprise for a
number of future periods. Accounting standards regarding long-lived assets involve
determination of the appropriate cost at which to record the assets initially, the amount
at which to present the assets at subsequent reporting dates, and the appropriate
method(s) to be used to allocate the cost or other recorded values over the periods being
benefited. Under international accounting standards, while historical cost is the defined
benchmark treatment, revalued amounts may also be used for presenting long-lived
assets in the statement of financial position if certain conditions are met.
Long-lived assets are primarily operational in character, and they may be classified into
two basic types: tangible and intangible. Tangible assets have physical substance, while
intangible assets either have no physical substance, or have a value that is not conveyed
by what physical substance they do have (e.g., the value of computer software is not
reasonably measured with reference to the cost of the diskettes on which these are
contained).
The value of an intangible asset is a function of the rights or privileges that its
ownership conveys to the business enterprise. Intangible assets can be further
categorized as either
1.
Identifiable, or
2.
Unidentifiable (i.e., goodwill).
Identifiable intangibles include patents, copyrights, brand names, customer lists, trade
names, and other specific rights that typically can be conveyed by an owner without
necessarily also transferring related physical assets. Goodwill, on the other hand,
cannot be meaningfully transferred to a new owner without also selling the other assets
and/or the operations of the business.
Research and development costs are also addressed in this chapter. Formerly the
subject of a separate international standard (IAS 9), but more recently guided by the
standard covering all intangibles (IAS 38), research costs must be expensed as incurred,
whereas development costs, as defined and subject to certain limitations, are to be
classified as assets and amortized over the period to be benefited.
The standard on impairment of assets (IAS 36) pertains to both tangible and intangible
long-lived assets. This chapter will consider the implications of this standard for the
accounting for intangible assets. The matter of goodwill, an unidentifiable intangible
asset deemed to be the residual cost of a business combination accounted for as an
acquisition, has been addressed by IAS 22 and is covered in Chapter 11; accounting for
all other intangibles, addressed in IAS 38, is discussed in this chapter.
As part of its twin projects considering revisions to the standards on business
combinations and related topics, which are now anticipated to result in new or revised
standards no earlier than 2004, the IASB has been reviewing the accounting for
intangibles in general. The objective is for the accounting for acquired intangibles,
including goodwill and in-process research and development, to be made more
consistent with that prescribed for intangibles acquired by other means or internally
generated by the reporting entity.
With regard to goodwill (discussed in greater detail in Chapter 11, Business
Combinations and Consolidated Financial Statements, it is expected that an acquirer
will be required, as of the acquisition date to
1.
Recognize goodwill acquired in a business combination as an asset; and
2.
Initially measure that goodwill at its cost, being the excess of the cost of the
business combination over the acquirer’s interest in the net fair value of the identifiable
assets, liabilities, and any contingent liabilities recognized.
It is well established that goodwill acquired in a business combination represents a
payment made by the acquirer in anticipation of future economic benefits from assets
that are not capable of being individually identified and separately recognized. To the
extent that the acquiree’s identifiable assets, liabilities, or contingent liabilities do not
satisfy the criteria for separate recognition at the acquisition date, there is a resulting
impact on the amount recognized as goodwill. This is because goodwill is measured as
the residual cost of the business combination after recognizing the acquiree’s
identifiable assets, liabilities, and contingent liabilities.
Under the anticipated IAS revisions, subsequent to initial recognition, the acquiring
entity will be required to measure goodwill acquired in a business combination at cost
less any accumulated impairment losses. This will essentially replicate the approach
adopted under US GAAP (SFAS 142), which is a stark departure from historical
practice. Rather than being amortized over its estimated economic life, goodwill
acquired in a business combination will have to be tested for impairments annually, or
more frequently if events or changes in circumstance indicate that it might be impaired,
in accordance with IAS 36.
Sources of IAS
IAS 36, 38
SIC 6, 32
DEFINITIONS OF TERMS
Amortization. In general, the systematic allocation of the cost of a long-term asset over
its useful economic life; the term is also used specifically to define the allocation
process for intangible assets.
Carrying amount. The amount at which an asset is presented on the balance sheet,
which is its cost (or other allowable basis), net of any accumulated depreciation and
impairment losses.
Cash generating unit. The smallest identifiable group of assets that generates cash
inflows from continuing use, largely independent of the cash inflows associated with
other assets or groups of assets.
Corporate assets. Assets, excluding goodwill, that contribute to future cash flows of
both the cash generating unit under review for impairment and other cash generating
units.
Cost. Amount of cash or cash equivalent paid or the fair value of other consideration
given to acquire or construct an asset.
Depreciable amount. Cost of an asset or the other amount that has been substituted for
cost, less the residual value of the asset.
Depreciation. Systematic and rational allocation of the depreciable amount of an asset
over its economic life.
Development. The application of research findings or other knowledge to a plan or
design for the production of new or substantially improved materials, devices, products,
processes, systems, or services prior to commencement of commercial production or
use. This should be distinguished from research.
Fair value. Amount that would be obtained for an asset in an arm’s-length exchange
transaction between knowledgeable willing parties.
Goodwill. The excess of the cost of a business combination accounted for as an
acquisition over the fair value of the net assets thereof, to be amortized over its useful
economic life that, as a rebuttable presumption, is no greater than twenty years.
Impairment loss. The excess of the carrying amount of an asset over its recoverable
amount.
Intangible assets. Nonmonetary assets without physical substance that are held for use
in the production or supply of goods or services or for rental to others, or for
administrative purposes, which are identifiable and are controlled by the enterprise as a
result of past events, and from which future economic benefits are expected to flow.
Monetary assets. Assets whose amounts are fixed in terms of units of currency.
Examples are cash, accounts receivable, and notes receivable.
Net selling price. The amount which could be realized from the sale of an asset by
means of an arm’s-length transaction, less costs of disposal.
Nonmonetary transactions. Exchanges and nonreciprocal transfers that involve little or
no monetary assets or liabilities.
Nonreciprocal transfer. Transfer of assets or services in one direction, either from an
enterprise to its owners or another entity, or from owners or another entity to the
enterprise. An enterprise’s reacquisition of its outstanding stock is a nonreciprocal
transfer.
Recoverable amount. The greater of an asset’s net selling price or its value in use.
Research. The original and planned investigation undertaken with the prospect of
gaining new scientific or technical knowledge and understanding. This should be
distinguished from development.
Residual value. Estimated amount expected to be obtained on ultimate disposition of
the asset after its useful life has ended, net of estimated costs of disposal.
Useful life. Period over which an asset will be employed in a productive capacity, as
measured either by the time over which it is expected to be used, or the number of
production units expected to be obtained from the asset by the enterprise.
CONCEPTS, RULES, AND EXAMPLES
Background
Over the years, the role of intangible assets has grown more important for the operations
and prosperity of many types of businesses, as the “knowledge-based” economy
becomes more dominant. However, until recently, accounting standards have tended to
give scant attention to, or ignore entirely, the appropriate means of reporting upon such
assets. As a consequence, practice has been exceptionally diverse, with enterprises in
nations whose standards had not addressed accounting for intangibles typically being
much more aggressive in capitalizing a range of intangibles, including internally
generated goodwill, vis-à-vis those entities operating under more strictly defined rules
limiting cost deferral and requiring rapid amortization of those costs which could be
deferred.
Thus, in many countries it has been common practice to defer recognition of certain
types of expenditures, including advertising costs and setup costs, the future benefits of
which are very difficult to demonstrate. In addition, when intangibles such as “brand
names” and “internally generated goodwill” have been capitalized, there has often been
a great reluctance to amortize the costs against earnings over a reasonable time horizon,
on the basis that these have either indefinite or infinite lives.
While advocates for such practices have made the claim that future benefits will flow
from such expenditures (else, why incur those costs?), experience has shown that these
deferrals often result in a subsequent year in large “big bath” write-offs. This pattern of
foregone periodic expense and sporadic charge-offs clearly impedes the utility of
financial statements for one of their primary purposes, namely, the predicting of future
economic performance (both in terms of earnings and cash flows) of the reporting
entity. While all can agree that predicting the useful economic lives of certain
intangibles is exceptionally challenging, the need to honor the matching principle and to
provide relevant information for use by investors, creditors and others has driven most
standard setters to impose rather stringent requirements on the recognition and
measurement of intangible assets.
International accounting standards first addressed accounting for intangibles in a
thorough way with IAS 38, which was promulgated after a rather long and contentious
gestation period that included the issuance of two Exposure Drafts. IAS 38 is a
comprehensive standard which superseded an earlier standard dealing solely with
research and development expenditures.
It establishes recognition criteria,
measurement bases, and disclosure requirements for intangible assets. The standard
also prescribes impairment testing for intangible assets, to be undertaken on a regular
basis. This is to ensure that only assets having recoverable values are capitalized and
carried forward to future periods.
It is interesting to note that in prescribing the amortization period, IAS 38 has ruled out
the concept of intangible assets having infinite or indefinite lives. In fact, by imposing
additional burdens on those who would assign lives greater than twenty years to such
assets, the standard set a rather conservative approach to recognition and measurement
of intangibles. However, the IASB is currently weighing revisions that would remove
the refutable presumption of a twenty-year maximum economic life and would further
acknowledge the existence of indefinite-life intangibles, not subject to amortization at
all (at least, until a finite life was determinable). These potential revisions are being
pondered largely as part of IASB’s effort to “converge” its standards, in this case to the
recently revised US GAAP standards on business combinations and intangibles. If
adopted, goodwill will no longer be subject to amortization, but will have to be
evaluated for impairment regularly, reversing the position taken by IAS 38. (See further
discussion in Chapter 11.)
Also, by simultaneously withdrawing the existing standard on research and
development costs (the former IAS 9) and revising the standard on business
combinations (IAS 22), the former IASC considerably streamlined and rationalized the
accounting standards relating to accounting for intangible assets. As the rules presently
exist, therefore, they do form a coherent and consistent set of requirements for the
financial reporting on all such assets.
Scope of the standard. The standard applies to all enterprises. It prescribes the
accounting treatment for intangible assets, including development costs. However, it
does not apply to intangible assets covered by other IAS; for instance, deferred tax
assets covered under IAS 12, leases that fall within the purview of IAS 17, goodwill
arising on a business combination and dealt with by IAS 22, assets arising from
employee benefits that are covered by IAS 19, and financial assets as defined by IAS 32
and covered by IAS 27, 28, 31, and 39. This standard does not apply to intangible
assets arising in insurance companies from contracts with policyholders, nor to mineral
rights and the costs of exploration for, or development and extraction of, minerals, oil,
natural gas, and similar nonregenerative resources. However, the standard does apply to
intangible assets that are used to develop or maintain these activities.
Identifiable intangible assets include patents, copyrights, licenses, customer lists, brand
names, import quotas, computer software, leasehold improvements, marketing rights,
and specialized know-how. These items have in common the fact that there is little or
no tangible substance to them, they have an economic life of greater than one year, and
they have a decline in utility over that period which can be measured or reasonably
assumed. In many but not all cases, the asset is separable; that is, it could be sold or
otherwise disposed of without simultaneously disposing of or diminishing the value of
other assets held.
Intangible assets are, by definition, assets that have no physical substance. However,
there may be instances where intangibles also have some physical form. For example
•
There may be tangible evidence of an asset’s existence, such as a certificate
indicating that a patent had been granted, but this does constitute the asset itself;
•
Some intangible assets may be contained in or on a physical substance such as a
compact disc (in the case of computer software); and
•
Identifiable assets that result from research and development activities are
intangible assets because the tangible prototype or model is secondary to the knowledge
that is the primary outcome of those activities.
In the case of assets that have both tangible and intangible elements, there may be some
confusion about whether to classify them as tangible or intangible assets. Considerable
judgment is required in properly classifying such assets as either intangible or tangible
assets. As a rule of thumb, the asset should be classified as either an intangible asset or
a tangible asset based on the relative or comparative dominance or significance of the
tangible or the intangible component (or element) of the asset. For instance, computer
software that is not an integral part of the related hardware equipment is treated as
software (i.e., as an intangible asset). Conversely, certain computer software, such as
the operating system, that is essential and an integral part of a computer, is treated as
part of the hardware equipment (i.e., as property, plant, and equipment as opposed to an
intangible asset).
The concept embodied in this standard is somewhat controversial, and in some respects
also vague and unclear, being subjective and open to interpretation. In various attempts
to explain this concept, different techniques have been used by commentators. Some
have restricted themselves to detailed examples, while others (perhaps exhibiting over
enthusiasm to clarify the concept) have gone further, even so far as to argue that IAS 38
draws a distinction between an “intangible asset” and an “intangible resource.” In this
typology, the latter expression has been conceived of a broader concept that includes
intangible assets (as defined by IAS 38), as well as other hypothetical assets. For
example, intangible resources would include not only items such as patents and
copyrights (which would meet the qualifying criteria set forth for intangible assets in
IAS 38), but also items such as customer lists and internally generated brands (which do
not meet the definition of intangible assets). While this may serve some useful purpose,
the coining of a phrase such as “intangible resources” (which is found neither in the
IASC Framework nor in IAS 38) to be used in distinction from the term “intangible
asset,” is ill-advised. Given the fact that IAS 38 (paragraph 7) has defined an asset as a
“resource…controlled by the enterprise…”, the creation of alternative definitions and
concepts is probably not appropriate.
Recognition Criteria
Identifiable intangible assets have much similarity to tangible long-lived assets
(property, plant, and equipment), and the accounting for them is accordingly very
similar. The key criteria for determining whether intangible assets are to be recognized
are
1.
Whether the intangible asset has an identity separate from other aspects of the
business enterprise;
2.
Whether the use of the intangible asset is controlled by the enterprise as a result
of its past actions and events;
3.
Whether future economic benefits can be expected to flow to the enterprise; and
4.
Whether the cost of the asset can be measured reliably.
Identifiability. As to the first issue, the principal concern is to distinguish these
intangibles from goodwill arising from a business combination, the accounting for
which is addressed by IAS 22. Goodwill is the residual cost of a business acquisition
that cannot be assigned either to tangible assets, net of any liabilities assumed, or to
identifiable intangibles. Unlike identifiable intangibles, goodwill cannot be separated
from the assets (the physical as well as the identifiable intangible) it was acquired with.
Since goodwill cannot be severed and sold, its real value is often questioned and the
period over which it can be amortized is, accordingly, often made as brief as possible.
(But note that goodwill may become a nonamortizing, impairment-tested asset under a
revised or superseded IAS 22; see Chapter 11 for a discussion.)
To capitalize the cost of an intangible asset other than goodwill, it must have an
independently observable existence and a cost that can be assigned to it. Independently
observable existence can be established if the enterprise can rent, sell, exchange, or
distribute the future economic benefits from the assets without also disposing of other
assets; that is, that an owner can convey them without necessarily also transferring
related physical assets. Goodwill, on the other hand, cannot be meaningfully transferred
to a new owner without also selling other assets, and hence, will not meet the
recognition criteria for intangible assets as defined by IAS 38.
Identifiability can be demonstrated by a legal right over an asset or by the fact that the
asset is separable from the rest of the business. It is worth noting that while IAS 38
does not regard “separability” as an additional recognition criterion, some national
standards (UK GAAP, for instance) still retain it as one of the qualifying criteria for
recognition. At the time it adopted IAS 38, the IASC Board rejected the views of
commentators on the antecedent Exposure Drafts who had advocated the inclusion of
“separability” as an additional recognition criterion. In setting forth the basis for its
conclusions, the Board cited several reasons for this rejection. Among these, perhaps
the most noteworthy is the following:
…if a “separability” criterion was applicable to all intangible assets, many intangible
assets (for example, a license to operate a radio station) would not be shown separately
in the financial statements even if they meet the (IASC) Framework’s definition of, and
recognition criteria for, an asset.
While not supportive of imposing separability as a threshold criterion for intangible
assets, IASC supported the view that
1.
Demonstration of the separability of an asset can assist an enterprise in
identifying an intangible asset; and
2.
The inability of an enterprise to demonstrate the separability of an asset will
make it harder to demonstrate that there is an identifiable intangible asset.
Currently, IASB is embarked upon a thorough review of accounting for business
combinations, a corollary of which is the accounting for intangibles (including goodwill
and in-process research and development) acquired in such combinations. Based on
deliberations to mid-2002, it appears that the existing philosophy for intangible asset
recognition will be essentially continued. A replacement for IAS 22 will likely stipulate
that intangible assets acquired in a business combination should be recognized
separately from goodwill if they arise as a result of contractual or legal rights or are
separable from the business. The existence of contractual or legal rights and
separability will not, however, form part of the definition of an asset, but rather, will
serve as indicators that an entity controls the future economic benefits embodied in the
item. It would appear, therefore, that neither of these characteristics are intended to be
absolute requirements, which would continue current practice in this area.
Control. The provisions of IAS 38 require that an enterprise should be in a position to
control the use of the intangible asset. Control implies the power to both obtain future
economic benefits from the asset as well as restrict the access of others to those benefits.
Normally enterprises register patents, copyrights, etc. to ensure its control over an
intangible asset. A patent gives the holder the exclusive right to use the underlying
product or process without any interference or infringement from others. Intangible
assets arising from technical knowledge of staff, customer loyalty, long-term training
benefits, etc., will have difficulty meeting this recognition criteria in spite of expected
future economic benefits from them. This is due to the fact that the enterprise would
find it impossible to fully control these resources or to prevent others from controlling
them.
For instance, even if an enterprise incurs considerable expenditure on training that will
supposedly increase staff skills, the economic benefits from skilled staff cannot be
controlled, since trained employees could leave their current employment and move on
in their career to other employers. Hence, staff training expenditures, no matter how
material in amount, do not qualify as an intangible asset. In other words, the practice of
deferring training costs based on the reasoning that future economic benefits from
enhanced staff skills will flow to the enterprise can no longer be justified, after the
promulgation of the IAS on Intangible Assets. Other often-quoted examples of
expenses that do not qualify as intangible assets based on the criterion of control are
market share, customer relationships, customer loyalty (unless protected by enforceable
legal rights), and portfolio of clients.
Future economic benefits. Under IAS 38, it is mandated that an intangible asset be
recognized only if it is probable that future economic benefits specifically associated
therewith will flow to the reporting entity, and the cost of the asset can be measured
reliably. The recognition criteria for intangible assets are derived from the (IASC)
Framework and are similar to the recognition criteria for tangible assets (property, plant,
and equipment).
The future economic benefits envisaged by the standard may take the form of revenue
from the sale of products or services, cost savings, or other benefits resulting from the
use of the intangible asset by the enterprise. A good example of other benefits resulting
from the use of the intangible asset is the use by an enterprise of a secret formula (which
the enterprise has protected legally) that leads to reduced future production costs (as
opposed to increased future revenue).
Measurement of Cost of Intangibles
The conditions under which the intangible asset has been acquired will determine the
measurement of cost.
The cost of an intangible asset acquired separately is determined in a manner largely
analogous to that for tangible long-lived assets as described in Chapter 8. Thus, the cost
comprises the purchase cost, including any taxes and import duties, less any trade
discounts and rebates, plus any directly attributable expenditures incurred in preparing
the asset for its intended use. Directly attributable expenditures would include fully
loaded labor costs, thus including employee benefits arising directly from bringing the
asset to its working condition. It would also include professional fees and other costs.
As with tangible assets, capitalization of costs ceases at the point when the intangible
asset is ready to be placed in service in the manner intended by management. Any costs
incurred in using or redeploying intangible assets are accordingly to be excluded from
the cost of those assets. Thus, any costs incurred while the asset is capable of being
used in the manner intended by management, but while it has yet to be placed into
service, would be expenses, not capitalized. Similarly, initial operating losses, such as
those incurred while demand for the asset’s productive outputs is being developed,
cannot be capitalized. On the other hand, further expenditures made for the purpose of
improving the asset’s level of performance would qualify for capitalization.
Changes being made to IAS 38 as a consequence of the IASB’s Improvements Project
will emphasize the fact that certain operations may occur in connection with the
development of an intangible asset, but not be necessary in order to bring the asset to
the condition where it would be capable of operating in the manner intended by
management. These incidental operations could occur either before or during the
development activities. Because by definition such operations are not necessary to
bring an asset to the condition necessary for it to be capable of operating in the manner
intended by management, the income and related expenses of incidental operations must
be recognized in the operating results for the current period, to be reported in the
respective classification of income and expense.
Under IAS 38, a condition for the recognition of an intangible asset is that the cost of
the asset can be measured reliably. The changes made to IAS 38 consequent to the
IASB’s Improvements Project clarified that the reporting entity would be unable to
determine reliably the fair value of an intangible asset when comparable market
transactions are infrequent and when alternative estimates of fair value (e.g., those
based on discounted cash flow projections) cannot be calculated. Furthermore, the cost
of an intangible asset acquired in exchange for a similar asset would be measured at the
carrying amount of the asset given up when the fair value of neither of the assets
exchanged could be easily determined reliably.
In some situations, identifiable intangibles are acquired as part of a business
combination or other bulk purchase transaction. According to the provisions of IAS 38,
the cost of an intangible asset acquired as part of a business combination is its fair value
as at the date of acquisition. If the intangible asset can be freely traded in an active
market, then the quoted market price is the best measurement of cost. If the intangible
asset has no active market, then cost is determined based on the amount that the
enterprise would have paid for the asset in an arm’s-length transaction at the date of
acquisition. If the cost of an intangible asset acquired as part of a business combination
cannot be measured reliably, then that asset is not recognized, but rather, is included in
goodwill.
Under US GAAP, the aggregate purchase cost is to be allocated to assets acquired and
liabilities assumed. If one or more of the assets are intangibles, the extent of judgment
required in the allocation process becomes somewhat greater than would otherwise be
the case; in extreme situations it may be impossible to determine how much, if any, of
the aggregate cost should be allocated to intangibles. It is most likely to be
determinable when the intangibles were actually negotiated for in the transaction rather
than being thrown in to the deal. Furthermore, if the allocation of the purchase price to
individual assets is accomplished by applying discounted present value measures to
future revenue streams, unless this same process is usable with regard to the intangibles,
it is likely that any unallocated purchase price will have to be assigned to goodwill.
In some instances, intangible assets are obtained in exchange for equity instruments of
the reporting entity. The revisions to IAS 38 will stipulate that under such
circumstances the cost of the asset is the fair value of the equity instruments issued.
Where the fair value for the item received is more clearly evident than the fair value of
the equity instruments issued, however, that should be used to measure its cost.
In other situations, intangible assets may be acquired in exchange or part exchange for
other dissimilar intangible assets or other assets. Unless the “like-kind” exception
described in the following paragraph applies, the costs of the assets obtained are
measured at the fair values of the assets given up, adjusted by the amount of any cash or
cash equivalents transferred. However, if the fair values of the assets received are more
clearly evident than the fair values of the assets given up, those values are to be used to
measure the transaction. These procedures are predicated upon the ability to reliably
measure costs; absent this ability, as when comparable market transactions are
infrequent and alternative estimates of fair value (e.g., based on discounted cash flow
projections) cannot be calculated, acquired assets would not be subject to recordation.
The revisions to IAS 38 also will establish accounting procedures for what is commonly
known as a like-kind exchange. In such instances, the cost of an intangible asset
acquired is measured at the carrying amount of the asset given up when the fair value of
neither of the assets exchanged can be determined reliably.
Internally generated goodwill is not recognized as an intangible asset because it fails to
meet the recognition criteria of
•
Reliable measurement at cost,
•
Lack of an identity separate from other resources, and
•
Control by the reporting enterprise.
In practice, accountants are usually confronted with the desire to recognize internally
generated goodwill based on the premise that at a certain point in time the market value
of an enterprise exceeds the carrying value of its identifiable net assets. However, as
IAS 38 categorically points out, such differences cannot be considered to represent the
cost of intangible assets controlled by the enterprise, and hence, would not meet the
criteria for recognition (i.e., capitalization) of such an asset on the books of the
enterprise.
Intangibles acquired by means of government grants. If the intangible is acquired free
of charge or by payment of nominal consideration, as by means of a government grant
(e.g., when the government grants the right to operate a radio station) or similar
program, and assuming the benchmark accounting treatment (historical cost) is
employed, obviously there will be little or no amount reflected as an asset. If the asset
is important to the reporting entity’s operations, however, it must be adequately
disclosed in the notes to the financial statements. If the allowed alternative (fair value)
method is used, the fair value should be determined by reference to an active market.
However, given the probable lack of an active market, since government grants are
generally not transferable, it is unlikely that this situation will be encountered. If an
active market does not exist for this type of an intangible asset, the enterprise must
recognize the asset at cost. Cost would include those that are directly attributable to
preparing the asset for its intended use.
Intangibles Acquired through an Exchange of Assets
If an intangible asset is acquired in exchange or partial exchange for a dissimilar
intangible or other asset, then the cost of the asset is measured at its fair value. This
amount is to be ascertained by reference to the fair value of the asset received, which is
equivalent to the fair value of the asset given up in the exchange, adjusted for any cash
or cash equivalents transferred.
If the exchange involves similar assets to be used by the enterprise in essentially the
same manner and for the same purpose as the item given up in the exchange, the
exchange is not deemed to be the culmination of an earnings process, and accordingly,
no gain or loss is recognized. The new asset will be recorded at the carrying amount of
the asset given up, adjusted for any cash or cash equivalent (often called “boot”) given
or received.
Internally Generated Intangibles other than Goodwill
In many instances, intangibles are generated internally by an entity, rather than being
acquired via a business combination or some other purchase transaction. Because of the
nature of intangibles, the actual measurement of the cost (i.e., the initial amounts at
which these could be recognized as assets) can prove to be rather challenging in
practice, and for that reason, historically there was somewhat of a bias against
recognition of internally generated intangible assets. However, a failure to recognize
such assets would not only cause the entity’s balance sheet to underreport its economic
resources, but would also result in a mismatching of income and expense in both the
period of expenditure and later periods when the related benefits would be reaped.
Accordingly, IAS 38 provides that internally generated intangible assets, provided
certain criteria are met, are to be capitalized and amortized over the projected period of
economic utility.
Under the now-superseded IAS 9, it was established that research costs were to be
expensed as incurred, but that development costs were to be deferred (i.e., capitalized)
and expensed over the periods of expected benefit. IAS 38 absorbed the guidance
formerly found in IAS 9 and expanded it to cover other internally generated intangible
assets. Thus, expenditures pertaining to the creation of intangible assets are to be
classified alternatively as being indicative of, or analogous to, research activity or
development activity. The former costs are expensed as incurred; the latter are
capitalized, if future economic benefits are reasonably likely to be received by the
reporting entity. Per IAS 38,
1.
Costs incurred in the research phase are expensed immediately; and
2.
If costs incurred in the development phase meet the recognition criteria for an
intangible asset, such costs should be capitalized. However, once costs have been
expensed during the development phase, they cannot later be capitalized.
In practice, distinguishing research-like expenditures from development-like
expenditures may not be easily accomplished. This would be especially true in the case
of intangibles for which the measurement of economic benefits cannot be performed in
anything approximating a direct manner. Assets such as brand names, mastheads, and
customer lists can prove quite resistant to such direct observation of value (although in
many industries there are benchmark monetary amounts commonly associated with
such items, such as the oft-expressed notion that a customer list in the securities
brokerage business is worth $1,500 per name, implying the amount of avoidable
promotional costs each qualified name is worth).
Thus, entities may incur certain expenditures in order to enhance brand names, such as
engaging in image-advertising campaigns, but these costs will also have ancillary
benefits, such as promoting specific products that are being sold currently, and possibly
even enhancing employee morale and performance. While it may be argued that the
expenditures create or add to an intangible asset, as a practical matter it would be
difficult to determine what portion of the expenditures relate to which achievement, and
to ascertain how much, if any, of the cost may be capitalized as part of brand names.
Thus, it is considered to be unlikely that threshold criteria for recognition can be met in
such a case. For this reason the standard has specifically disallowed the capitalization
of internally generated assets like brands, mastheads, publishing titles, customer lists,
and items similar to these in substance.
Apart from the prohibited items, however, IAS 38 permits recognition of internally
created intangible assets to the extent the expenditures can be analogized to the
development phase of a research and development program. Thus, internally developed
patents, copyrights, trademarks, franchises, and other assets will be recognized at the
cost of creation, exclusive of costs which would be analogous to research, as further
explained in the following paragraphs.
When an internally generated intangible asset meets the recognition criteria, the cost is
determined using the same principles as for an acquired tangible asset. Thus, cost
comprises all costs directly attributable to creating, producing, and preparing the asset
for its intended use. IAS 38 closely follows IAS 16 with regard to elements of cost that
may be considered as part of the asset, and the need to recognize the cash equivalent
price when the acquisition transaction provides for deferred payment terms. As with
self-constructed tangible assets, elements of profit must be eliminated from amounts
capitalized, but incremental administrative and other overhead costs can be allocated to
the intangible and included in the asset’s cost. Initial operating losses, on the other
hand, cannot be deferred by being added to the cost of the intangible, but must be
expensed as incurred.
As noted above, the standard presents the concepts of the research phase and the
development phase of a research and development project. IAS 38 mandates that the
expenditure incurred during the research phase of an internal project should be
recognized as an expense when incurred (as opposed to recognizing it as an intangible
asset). The standard takes this view based on the premise that an enterprise cannot
demonstrate that the expenditure incurred in the research phase will generate probable
future economic benefits, and consequently, that an intangible asset exists (thus, such
expenditure should be expensed). Examples of research activities include: activities
aimed at obtaining new knowledge; the search for, evaluation, and final selection of
applications of research findings; and the search for and formulation of alternatives for
new and improved systems, etc.
The standard recognizes that the development stage is further advanced than the
research stage, and that an enterprise can possibly, in certain cases, identify an
intangible asset and demonstrate that this asset will probably generate future economic
benefits for the organization. Thus, the standard allows recognition of an intangible
asset during the development phase, provided the enterprise can demonstrate all the
following:
•
Technical feasibility of completing the intangible asset so that it will be
available for use or sale;
•
Its intention to complete the intangible asset and either use it or sell it;
•
Its ability to use or sell the intangible asset;
•
The mechanism by which the intangible will generate probable future economic
benefits;
•
The availability of adequate technical, financial and other resources to complete
the development and to use or sell the intangible asset; and
•
The entity’s ability to reliably measure the expenditure attributable to the
intangible asset during its development.
Examples of development activities include: the design and testing of preproduction
models; design of tools, jigs, molds, and dies; design of a pilot plant which is not
otherwise commercially feasible; design and testing of a preferred alternative for new
and improved systems, etc.
Recognition of internally generated computer software costs. The recognition of
computer software costs poses several questions.
1.
In the case of a company developing software programs for sale, should the
costs incurred in developing the software be expensed, or should the costs be capitalized
and amortized?
2.
Is the treatment for developing software programs different if the program is to
be used for in-house applications only?
3.
In the case of purchased software, should the cost of the software be capitalized
as a tangible asset or as an intangible asset, or should it be expensed fully and
immediately?
In view of the current IAS on intangible assets, the position can be clarified as follows:
1.
In the case of a software-developing company, the costs incurred in the
development of software programs are research and development costs. Accordingly,
all expenses incurred in the research phase would be expensed. Thus, all expenses
incurred until technological feasibility for the product has been established should be
expensed. The enterprise would have to demonstrate technical feasibility and
probability of its commercial success. Technological feasibility would be established if
the enterprise has completed a detailed program design or working model. The
enterprise should have completed the planning, designing, coding, and testing activities
and established that the product can be successfully produced. Apart from being
capable of production, the enterprise should demonstrate that it has the intention and
ability to use or sell the program. Action taken to obtain control over the program in the
form of copyrights or patents would support capitalization of these costs. At this stage
the software program would be able to meet the criteria of identifiability, control, and
future economic benefits, and can thus be capitalized and amortized as an intangible
asset.
2.
In the case of software internally developed for in-house use, for example, a
payroll program developed by the reporting enterprise itself, the accounting approach
would be different. While the program developed may have some utility to the
enterprise itself, it would be difficult to demonstrate how the program would generate
future economic benefits to the enterprise. Also, in the absence of any legal rights to
control the program or to prevent others from using it, the recognition criteria would not
be met. Further, the cost proposed to be capitalized should be recoverable. In view of
the impairment test prescribed by the standard, the carrying amount of the asset may not
be recoverable and would accordingly have to be adjusted. Considering the above facts,
such costs may need to be expensed.
3.
In the case of purchased software, the treatment would differ on a case-to-case
basis. Software purchased for sale would be treated as inventory. However, software
held for licensing or rental to others should be recognized as an intangible asset. On the
other hand, cost of software purchased by an enterprise for its own use and which is
integral to the hardware (because without that software the equipment cannot operate),
would be treated as part of cost of the hardware and capitalized as property, plant, or
equipment. Thus, the cost of an operating system purchased for an in-house computer,
or cost of software purchased for computer-controlled machine tool, are treated as part
of the related hardware.
Cost of other software programs should be treated as intangible assets (as opposed to
being capitalized along with the related hardware), as they are not an integral part of the
hardware. For example, the cost of payroll or inventory software (purchased) may be
treated as an intangible asset provided it meets the capitalization criteria under IAS 38
(in practice, the conservative approach would be to expense such costs as they are
incurred, since their ability to generate future economic benefits is always
questionable).
Costs Not Satisfying the IAS 38 Recognition Criteria
The standard has specifically provided that expenditures incurred for nonmonetary
intangible assets should be recognized as an expense unless
1.
It relates to an intangible asset dealt with in another IAS;
2.
The cost forms part of the cost of an intangible asset that meets the recognition
criteria prescribed by IAS 38; or
3.
It is acquired in a business combination and cannot be recognized as an
identifiable intangible asset. In this case, this expenditure should form part of the
amount attributable to goodwill as at the date of acquisition.
As a consequence of applying the above criteria, the following costs are expensed as
they are incurred:
•
Research costs;
•
Preopening costs to open a new facility or business, and plant start-up costs
incurred during a period prior to full-scale production or operation, unless these costs
are capitalized as part of the cost of an item of property, plant, and equipment;
•
Organization costs such as legal and secretarial costs, which are typically
incurred in establishing a legal entity;
•
Training costs involved in operating a business or a product line;
•
Advertising and related costs;
•
Relocation, restructuring, and other costs involved in organizing a business or
product line;
•
Customer lists, brands, mastheads, and publishing titles that are internally
generated.
Thus, the IASC has finally resolved the controversy regarding the potential deferral of
costs like preoperating expenses. In the past, many enterprises have been known to
defer setup costs and preoperating costs on the premise that benefits from them flow to
the enterprise over future periods as well. Due to the unequivocal stand taken by the
IASC on this contentious issue, enterprises can no longer defer such costs. Further, by
adding the provision relating to annual impairment testing of all internally generated
intangible assets being amortized (over a period exceeding twenty years), the IASC has
ensured that all such costs capitalized in the past would need to be adjusted for
impairment.
The criteria for recognition of intangible assets as provided in IAS 38 are rather
stringent, and many enterprises will find that expenditures either to acquire or to
develop intangible assets will fail the test for capitalization. In such instances, all these
costs must be expensed currently as incurred. Furthermore, once expensed, these costs
cannot be resurrected and capitalized in a later period, even if the conditions for such
treatment are later met. This is not meant, however, to preclude correction of an error
made in an earlier period if the conditions for capitalization were met but interpreted
incorrectly by the reporting entity at that time.)
Subsequently Incurred Costs
Under the provisions of IAS 38, the capitalization of any subsequent costs incurred on
intangible assets is difficult to justify. This is because the nature of an intangible asset
is such that, in many cases, it is not possible to determine whether subsequent costs are
likely to enhance the specific economic benefits that will flow to the enterprise from
those assets. Thus, subsequent costs incurred on an intangible asset should be
recognized as an expense when they are incurred unless
1.
It is probable that those costs will enable the asset to generate specifically
attributable future economic benefits in excess of its assessed standard of performance
immediately prior to the incremental expenditure; and
2.
Those costs can be measured reliably and attributed to the asset reliably.
Thus, if the above two criteria are met, any subsequent expenditure on an intangible
after its purchase or its completion should be capitalized along with its cost. The
following example should help to illustrate this point better.
Example
An enterprise is developing a new product. Costs incurred by the R&D department in
2003 on the “research phase” amounted to $200,000. In 2004, technical and
commercial feasibility of the product was established. Costs incurred in 2004 were
$20,000 personnel costs and $15,000 legal fees to register the patent. In 2005, the
enterprise incurred $30,000 to successfully defend a legal suit to protect the patent. The
enterprise would account for these costs as follows:
•
Research and development costs incurred in 2003, amounting to $200,000,
should be expensed, as they do not meet the recognition criteria for intangible assets.
The costs do not result in an identifiable asset capable of generating future economic
benefits.
•
Personnel and legal costs incurred in 2004, amounting to $35,000, would be
capitalized as patents. The company has established technical and commercial
feasibility of the product, as well as obtained control over the use of the asset. The
standard specifically prohibits the reinstatement of costs previously recognized as an
expense. Thus $200,000, recognized as an expense in the previous financial statements,
cannot be reinstated and capitalized.
•
Legal costs of $30,000 incurred in 2005 to defend the enterprise in a patent
lawsuit should be expensed. Under US GAAP, legal fees and other costs incurred in
successfully defending a patent lawsuit can be capitalized in the patents account, to the
extent that value is evident, because such costs are incurred to establish the legal rights
of the owner of the patent. However, in view of the stringent conditions imposed by
IAS 38 concerning the recognition of subsequent costs, the IASC seems to be in favor
of the conservative approach of expensing such costs. Only such subsequent costs
should be capitalized which would enable the asset to generate future economic benefits
in excess of the originally assessed standards of performance. This represents, in most
instances, a very high, possibly insurmountable hurdle. Thus, legal costs incurred in
connection with defending the patent, which could be considered as expenses incurred
to maintain the asset at its originally assessed standard of performance, would not meet
the recognition criteria under IAS 38.
•
Alternatively, if the enterprise were to lose the patent lawsuit, then the useful life
and the recoverable amount of the intangible asset would be in question. The enterprise
would be required to provide for any impairment loss, and in all probability, even to
fully write off
the intangible asset. What is required must be determined by the facts of the specific
situation.
Measurement subsequent to Initial Recognition
Benchmark treatment. After initial recognition, an intangible asset should be carried at
its cost less any accumulated amortization and any accumulated impairment losses.
Allowed alternative treatment—revaluation. As with tangible assets under IAS 16, the
standard for intangibles permits revaluation subsequent to original acquisition, with the
asset being written up to fair value. Inasmuch as most of the particulars of IAS 38
follow IAS 16 to the letter, and were described in detail in Chapter 8, these will not be
repeated here. The unique features of IAS 38 are as follows:
1.
If the intangibles were not initially recognized (i.e., they were expensed rather
than capitalized) it would not be possible to later recognize them at fair value.
2.
Deriving fair value by applying a present value concept to projected cash flows
(a technique that can be used in the case of tangible assets under IAS 16) is deemed to
be too unreliable in the realm of intangibles, primarily because it would tend to
commingle the impact of identifiable assets and goodwill. Accordingly, fair value of an
intangible asset should only be determined by reference to an active market in that type
of intangible asset. Active markets providing meaningful data are not expected to exist
for such unique assets as patents and trademarks, and thus it is presumed that
revaluation will not be applied to these types of assets in the normal course of business.
As a consequence, the IASC has effectively restricted revaluation of intangible assets to
only freely tradable intangible assets.
As with the rules pertaining to plant, property, and equipment under IAS 16, if some
intangible assets in a given class are subjected to revaluation, all the assets in that class
should be consistently accounted for unless fair value information is not or ceases to be
available. Also in common with the requirements for tangible fixed assets, IAS 38
requires that revaluations be taken directly to equity through the use of a revaluation
surplus account, except to the extent that previous impairments had been recognized by
a charge against income.
Example of revaluation of intangible assets
A patent right is acquired July 1, 2003, for $250,000; while it has a legal life of 15
years, due to rapidly changing technology, management estimates a useful life of only 5
years. Straight-line amortization will be used. At January 1, 2004, management is
uncertain that the process can actually be made economically feasible, and decides to
write down the patent to an estimated market value of $75,000. Amortization will be
taken over 3 years from that point. On January 1, 2006, having perfected the related
production process, the asset is now appraised at a sound value of $300,000.
Furthermore, the estimated useful life is now believed to be 6 more years. The entries
to reflect these events are as follows:
7/1/03 Patent 250,000
Cash, etc.
250,000
12/31/03
Amortization expense 25,000
Patent
25,000
1/1/04 Loss from asset impairment 150,000
Patent
150,000
12/31/04
Amortization expense 25,000
Patent
25,000
12/31/05
Amortization expense 25,000
Patent
25,000
1/1/06 Patent 275,000
Gain on asset value recovery
100,000
Revaluation surplus
175,000
Certain of the entries in the foregoing example will be explained further. The entry at
year-end 2003 is to record amortization based on original cost, since there had been no
revaluations through that time; only a half-year amortization is provided [($250,000/5)
x ½]. On January 1, 2004, the impairment is recorded by writing down the asset to the
estimated value of $75,000, which necessitates a $150,000 charge to income (carrying
value, $225,000, less fair value, $75,000).
In 2004 and 2005, amortization must be provided on the new lower value recorded at
the beginning of 2004; furthermore, since the new estimated life was 3 years from
January 2004, annual amortization will be $25,000.
As of January 1, 2006, the carrying value of the patent is $25,000; had the January 2004
revaluation not been made, the carrying value would have been $125,000 ($250,000
original cost, less 2.5 years amortization versus an original estimated life of 5 years).
The new appraised value is $300,000, which will fully recover the earlier write-down
and add even more asset value than the originally recognized cost. Under the guidance
of IAS 38, the recovery of $100,000 that had been charged to expense should be taken
into income; the excess will be credited to stockholders’ equity.
Development costs pose a special problem in terms of the application of the allowed
alternative method under IAS 38. The utilization of the allowed alternative method of
accounting for long-lived intangibles is only permissible when stringent conditions are
met concerning the availability of fair value information. In general, it will not be
possible to obtain fair value data from active markets, as is required by IAS 38, and this
is particularly true with regard to development costs. Accordingly, the expectation is
that the benchmark (historical cost) method will be almost universally applied for
development costs. The use of the available alternative method for development costs,
while theoretically valid, is expected to be very unusual in practice.
Example of development cost capitalization
Assume that Creative, Incorporated incurs substantial research and development costs
for the invention of new products, many of which are brought to market successfully.
In particular, Creative has incurred costs during 2003 amounting to $750,000, relative to
a new manufacturing process. Of these costs, $600,000 were incurred prior to
December 1, 2003. As of December 31, the viability of the new process was still not
known, although testing had been conducted on December 1. In fact, results were not
conclusively known until February 15, 2004, after another $75,000 in costs were
incurred post–January 1. Creative, Incorporated’s financial statements for 2003 were
issued February 10, 2004, and the full $750,000 in research and development costs were
expensed, since it was not yet known whether a portion of these qualified as
development costs under IAS 38. When it is learned that feasibility had, in fact, been
shown as of December 1, Creative management asks to restore the $150,000 of post–
December 1 costs as a development asset. Under IAS 38 this is prohibited. However,
the 2004 costs ($75,000 thus far) would qualify for capitalization, in all likelihood,
based on the facts known.
If, however, it is determined that fair value information derived from active markets is
indeed available, and the enterprise desires to apply the allowed alternative (revaluation)
method of accounting to development costs, then it will be necessary to perform
revaluations on a regular basis, such that at any reporting date the carrying amounts are
not materially different from the current fair values. From a mechanical perspective, the
adjustment to fair value can be accomplished either by “grossing up” the cost and the
accumulated amortization accounts proportionally, or by netting the accumulated
amortization, prerevaluation, against the asset account and then restating the asset to the
net fair value as of the revaluation date. In either case, the net effect of the upward
revaluation will be recorded in stockholders’ equity as revaluation surplus; the only
exception would be when an upward revaluation is in effect a reversal of a previously
recognized impairment which was reported as a charge against earnings or a revaluation
decrease (reversal or a yet earlier upward adjustment) which was reflected in earnings.
The accounting for revaluations is illustrated as follows:
Example of accounting for revaluation of development cost
Assume Breakthrough, Inc. has accumulated development costs that meet the criteria
for capitalization at December 31, 2003, amounting to $39,000. It is estimated that the
useful life of this intangible asset will be 6 years; accordingly, amortization of $6,500
per year is anticipated. Breakthrough uses the allowed alternative method of accounting
for its long-lived tangible and intangible assets. At December 31, 2005, it obtains
market information regarding the then-current fair value of this intangible asset, which
suggests a current fair value of these development costs is $40,000; the estimated useful
life, however, has not changed. There are two ways to apply IAS 38: the asset and
accumulated amortization can be “grossed up” to reflect the new fair value information,
or the asset can be restated on a “net” basis. These are both illustrated below. For both
illustrations, the book value (amortized cost) immediately prior to the revaluation is
$39,000 – (2 x $6,500) = $26,000. The net upward revaluation is given by the
difference between fair value and book value, or $40,000 – $26,000 = $14,000.
If the “gross up” method is used: Since the fair value after 2 years of the 6-year useful
life have already elapsed is found to be $40,000, the gross fair value must be 6/4 x
$40,000 = $60,000. The entries to record this would be as follows:
Development cost (asset)
21,000
Accumulated amortization—development cost
Revaluation surplus (stockholders’ equity)
7,000
14,000
If the “netting” method is used: Under this variant, the accumulated amortization as of
the date of the revaluation is eliminated against the asset account, which is then adjusted
to reflect the net fair value.
Accumulated amortization—development cost
Development cost (asset)
13,000
Development cost (asset)
14,000
Revaluation surplus (stockholders’ equity)
13,000
14,000
Amortization Period
As with tangible assets subject to depreciation or depletion, the cost (or revalued
carrying amount) of intangible assets is subject to rational and systematic amortization.
Given that the useful economic life of many intangibles would be difficult to assess, the
rule is that a maximum twenty-year life is permissible, with amortization being over a
shorter useful life if known. The only exceptions would occur in those instances where
the legal right has a life of greater than twenty years and either of the following
conditions exists:
1.
The intangible has an existence that is not separable from a specific tangible
asset, the useful life of which can be reliably determined to exceed twenty years, or
2.
There is an active secondary market for the intangible.
The thrust of these requirements is to make the twenty-year life an upper limit for most
intangibles.
If there is persuasive evidence that the useful life of an intangible asset is longer than
twenty years, then the twenty-year presumption is rebutted and the enterprise must
•
Amortize the intangible asset over that longer period;
•
Estimate the recoverable amount of the intangible asset at least annually in order
to identify any impairment loss; and
•
Disclose the reasons why the presumption has been rebutted.
Note that IAS 38 provides for amortization of all intangible assets; it does not subscribe
to the view that any intangible asset can possess an infinite life. The thrust of these
requirements is to make the twenty-year life an upper limit for most intangibles.
If control over the future economic benefits from an intangible asset is achieved through
legal rights for a finite period, then the useful life of the intangible asset should not
exceed the period of legal rights, unless the legal rights are renewable and the renewal is
a virtual certainty. Thus, as a practical matter, the shorter legal life will set the upper
limit for an amortization period in most cases.
The amortization method used should reflect the pattern in which the economic benefits
of the asset are consumed by the enterprise. Amortization should commence when the
asset is available for use and the amortization charge for each period should be
recognized as an expense unless it is included in the carrying amount of another asset
(e.g., inventory). Intangible assets may be amortized by the same systematic and
rational methods that are used to depreciate tangible fixed assets. Thus, IAS 38 would
seemingly permit straight-line, diminishing balance, and units of production methods.
If a method other than straight-line is used, it must accurately mirror the expiration of
the asset’s economic service potential.
Residual Value
Tangible assets often have a positive residual value before considering the disposal
costs because tangible assets can generally be sold for scrap, or possibly be transferred
to another user that has less need for or ability to afford new assets of that type.
Intangibles, on the other hand, lacking the physical attributes that would make scrap
value a meaningful concept, often have little or no residual worth. Accordingly, IAS 38
requires that a zero residual value be presumed unless an accurate measure of residual is
possible. Thus, the residual value is presumed to be zero unless
•
There is a commitment by a third party to purchase the asset at the end of its
useful life; or
•
There is an active market for that type of intangible asset, and residual value can
be measured reliably by reference to that market and it is probable that such a market
will exist at the end of the useful life.
IAS 38, as revised by the consequential changes wrought by the IASB Improvements
Project, specifies that the residual value of an intangible asset is the estimated net
amount that the reporting entity currently expects to obtain from disposal of the asset at
the end of its useful life, after deducting the estimated costs of disposal, if the asset were
of the age and in the condition expected at the end of its estimated useful life. In other
words, changes in prices or other variables over the expected period of use of the asset
are not to be included in the estimated residual value, since this would result in the
recognition of estimated holding gains over the life of the asset (via reduced
amortization that would be the consequence of a higher estimated residual value).
Residual value is to be assessed at each balance sheet date. Any change to the estimated
residual, other than that resulting from impairment (accounted for under IAS 36) is to be
accounted for prospectively, only by varying future periodic amortization. Similarly,
any change in amortization method (e.g., from accelerated to straight-line) is dealt with
as a change in estimate, again to be reflected only in future periodic charges for
amortization.
Periodic review of useful life assumptions and amortization methods employed. As for
fixed assets accounted for in conformity with IAS 16, the newer standard on intangibles
suggests that the amortization period be reconsidered at the end of each reporting
period, and that the method of amortization also be reviewed at similar intervals. There
is the expectation that due to their nature intangibles are more likely to require revisions
to one or both of these judgments. In either case, a change would be accounted for as a
change in estimate, affecting current and future periods’ reported earnings but not
requiring restatement of previously reported periods.
Impairment Losses
IAS 38 has provided that
•
Amortization of an asset should commence when the asset is available for use;
and
•
The amortization period should not exceed twenty years, although this
presumption is rebuttable.
In view of the above, some enterprises may be tempted to
•
Capitalize intangible assets and defer amortization for long periods on the
grounds that the assets are not available for use; and/or
•
Rebut the presumption of twenty-year life and amortize assets over a longer
period.
To combat the risk that either of these strategies might be employed, the standard
provides that in addition to the universal provisions of IAS 36 (which require that the
recoverable amount of an asset should be estimated when certain indications of
impairment exist, as described in detail in Chapter 8), IAS 38 requires that an enterprise
should estimate the recoverable amount of the following intangible assets at least at
each financial year-end even if there is no indication of impairment:
1.
Intangible assets that are not yet ready for use; and
2.
Other intangible assets that are amortized over a period exceeding twenty years
from the date when the asset becomes available for use.
Apart from the special case of assets not yet in use, or being amortized over greater than
twenty years, the major complication arises in the context of goodwill. Unlike other
intangible assets that are individually identifiable, goodwill is amorphous and cannot
exist, from a financial reporting perspective, apart from the tangible and identifiable
intangible assets with which it was acquired. Thus, a direct evaluation of the
recoverable amount of goodwill is not actually feasible; accordingly, the standard
requires that goodwill be combined with other assets which together define a cash
generating unit, and that an evaluation of any potential impairment (if warranted by the
facts and circumstances) be conducted on an aggregate basis. A more detailed
consideration of goodwill is presented in Chapter 11.
The impairment of intangible assets other than goodwill (such as patents, copyrights,
trade names, customer lists, and franchise rights) should be considered in precisely the
same way that long-lived tangible assets are dealt with. Carrying amounts must be
compared to the greater of net selling price or value in use when there are indications
that an impairment may have been suffered. Reversals of impairment losses under
defined conditions are also recognized. The effects of impairment recognitions and
reversals will be reflected in current period operating results, if the intangible assets in
question are being accounted for in accordance with the benchmark method set forth in
IAS 38 (i.e., at historical cost). On the other hand, if the allowed alternative method
(presenting intangible assets at revalued amounts) is followed, impairments will
normally be charged to stockholders’ equity to the extent that revaluation surplus exists,
and only to the extent that the loss exceeds previously recognized valuation surplus will
the impairment loss be reported as a charge against earnings. Recoveries are handled
consistent with the method by which impairments were reported, in a manner entirely
analogous to the explanation earlier in this chapter dealing with impairments of plant,
property, and equipment.
Disposals of Intangible Assets
With regard to questions of accounting for the disposition of assets, the guidance of IAS
38 virtually mirrors that of IAS 16. Gain or loss recognition will be for the difference
between carrying amount (net, if applicable, of any remaining revaluation surplus) and
the net proceeds from the sale. The amendment to IAS 38 made by the IASB’s
Improvements Project observes that a disposal of an intangible asset may result from
either a sale of the asset or by entering into a finance lease. The determination of the
date of disposal of the intangible asset is made by applying the criteria in IAS 18 for
recognizing revenue from the sale of goods, or IAS 17 in the case of disposal by a sale
and leaseback. As for other similar transactions, the consideration receivable on
disposal of an intangible asset is to be recognized initially at fair value. If payment for
such an intangible asset is deferred, the consideration received is recognized initially at
the cash price equivalent, with any difference between the nominal amount of the
consideration and the cash price equivalent to be recognized as interest revenue under
IAS 18, using the effective yield method.
Website Development and Operating Costs
With the advent of the Internet and growing popularity of “e-commerce,” many
businesses now have their own websites. Websites have become integral to doing
business and may be designed either for external or internal access. Those designed for
external access are developed and maintained for the purposes of promotion and
advertising of an entity’s products and services to their potential consumers. On the
other hand, those developed for internal access may be used for displaying company
policies and storing customer details.
With substantial costs being incurred by many entities for website development and
maintenance, the need for accounting guidance became evident. The recently
promulgated interpretation, SIC 32, concluded that such costs represent an internally
generated intangible asset that is subject to the requirements of IAS 38, and that such
costs should be recognized if, and only if, an enterprise can satisfy the requirements of
IAS 38, paragraph 45. Therefore, website costs have been likened to “development
phase” (as opposed to “research phase”) costs.
Thus the stringent qualifying conditions applicable to the development phase, such as
“ability to generate future economic benefits,” have to be met if such costs are to be
recognized as an intangible asset. If an enterprise is not able to demonstrate how a
website developed solely or primarily for promoting and advertising its own products
and services will generate probable future economic benefits, all expenditure on
developing such a website should be recognized as an expense when incurred.
Any internal expenditure on development and operation of the website should be
accounted for in accordance with IAS 38. Comprehensive additional guidance is
provided in the Appendix to the Interpretation and is summarized below.
1.
Planning stage expenditures, such as undertaking feasibility studies, defining
hardware and software specifications, evaluating alternative products and suppliers, and
selecting preferences, should be expensed;
2.
Application and infrastructure development costs pertaining to acquisition of
tangible assets, such as purchasing and developing hardware, should be dealt with in
accordance with IAS 16;
3.
Other application and infrastructure development costs, such as obtaining a
domain name, developing operating software, developing code for the application,
installing developed applications on the web server and stress testing, should be
expensed when incurred unless the conditions prescribed by IAS 38, paragraphs 19 and
45, are met;
4.
Graphical design development costs, such as designing the appearance of web
pages, should be expensed when incurred unless conditions prescribed by IAS 38,
paragraphs 19 and 45, are met;
5.
Content development costs, such as creating, purchasing, preparing, and
uploading information on the website before completion of the website’s development
should be expensed when incurred under IAS 38, paragraph 57(c), to the extent content
is developed to advertise and promote an enterprise’s own products or services;
otherwise, expensed when incurred, unless expenditure meets conditions prescribed by
IAS 38, paragraphs 19 and 45;
6.
Operating costs, such as updating graphics and revising content, adding new
functions, registering website with search engines, backing up data, reviewing security
access and analyzing usage of the website should be expensed when incurred, unless in
rare circumstances these costs meet the criteria prescribed in IAS 38, paragraph 60, in
which case such expenditure is capitalized as a cost of the website; and
7.
Other costs, such as selling and administrative overhead (excluding expenditure
which can be directly attributed to preparation of website for use), initial operating
losses and inefficiencies incurred before the website achieves planned performance, and
training costs of employees to operate the website, should be expensed when incurred.
This interpretation became effective in March 2002. The effects of adopting this
Interpretation was to be accounted for using the transition provisions originally
established by IAS 38. For instance, when a website does not meet the requirements of
this SIC but was previously recognized as an asset, the item was to be derecognized at
the date when this SIC becomes effective. If previously capitalized costs are written off
due to the imposition of SIC 32, the expense may be handled under either the
benchmark or alternative treatments specified by IAS 8.
Disclosure Requirements
The disclosure requirements set out in IAS 38 for intangible assets and those imposed
by IAS 16 for property, plant, and equipment are very similar, and both demand
extensive details to be disclosed in the financial statement footnotes. Another marked
similarity is the exemption from disclosing “comparative information” with respect to
the reconciliation of carrying amounts at the beginning and end of the period. While
this may be misconstrued as a departure from the well-known principle of presenting all
numerical information in comparative form, it is worth noting that it is in line with the
provisions of IAS 1. IAS 1, paragraph 38, categorically states that “(u)nless an
International Accounting Standard permits or requires otherwise, comparative
information should be disclosed in respect of the previous period for all numerical
information in the financial statements….” (Another standard that contains a similar
exemption from disclosure of comparative reconciliation information is IAS 37—please
refer to the relevant chapter of the book for details.)
For each class of intangible assets (distinguishing between internally generated and
other intangible assets), disclosure is required of
1.
The amortization method(s) used;
2.
Useful lives or amortization rates used;
3.
The gross carrying amount and accumulated amortization (including
accumulated impairment losses) at both the beginning and end of the period;
4.
A reconciliation of the carrying amount at the beginning and end of the period
showing additions, retirements, disposals, acquisitions by means of business
combinations, increases or decreases resulting from revaluations, reductions to
recognize impairments, amounts written back to recognize recoveries of prior
impairments, amortization during the period, the net effect of translation of foreign
entities’ financial statements, and any other material items; and
5.
The line item of the income statement in which the amortization charge of
intangible assets is included.
The standard explains the concept of “class of intangible assets” as a “grouping of assets
of similar nature and use in an enterprise’s operations.” Examples of intangible assets
that could be reported as separate classes (of intangible assets) are
1.
Brand names;
2.
Licenses and franchises;
3.
Mastheads and publishing titles;
4.
Computer software;
5.
Copyrights, patents and other industrial property rights, service and operating
right;
6.
Recipes, formulae, models, designs and prototypes; and
7.
Intangible assets under development.
The above list is only illustrative in nature. Intangible assets may be combined (or
disaggregated) to report larger classes (or smaller classes) of intangible assets if this
results in more relevant information for financial statement users.
In addition, the financial statements should also disclose the following:
1.
If the amortization period for any intangibles exceeds twenty years, the
justification therefor;
2.
The nature, carrying amount, and remaining amortization period of any
individual intangible asset that is material to the financial statements of the enterprise as
a whole;
3.
For intangible assets acquired by way of a government grant and initially
recognized at fair value, the fair value initially recognized, their carrying amount, and
whether they are carried under the benchmark or allowed alternative treatment for
subsequent measurement;
4.
Any restrictions on titles and any assets pledged as security for debt; and
5.
The amount of outstanding commitments for the acquisition of intangible assets.
In addition, the financial statements should disclose the aggregate amount of research
and development expenditure recognized as an expense during the period.
Examples of Financial Statement Disclosures
Novartis AG
For the Fiscal Year ending December 31, 2002
Notes to the consolidated financial statements
Intangible assets. These are valued at their cost and reviewed periodically and adjusted
for any diminution in value as noted in the preceding paragraph. Any resulting
impairment loss is recorded in the income statement in general overheads. In the case
of business combinations, the excess of the purchase price over the fair value of net
identifiable assets is recorded as goodwill in the balance sheet. Goodwill, which is
denominated in the local currency of the related acquisition, is amortized to income
through administration and general overheads on a straight-line basis over its useful life.
The amortization period is determined at the time of the acquisition, based upon the
particular circumstances, and ranges from five to twenty years. Goodwill relating to
acquisitions arising prior to January 1, 1995, has been fully written off against reserves.
Management determines the estimated useful life of goodwill based on its evaluation of
the respective company at the time of the acquisition, considering factors such as
existing market share, potential sales growth and other factors inherent in the acquired
company.
Other acquired intangible assets are written off on a straight-line basis over the
following periods:
Trademarks 10 to 15 years
Product and marketing rights 5 to 20 years
Software
3 years
Others 3 to 5 years
Trademarks are amortized on a straight-line basis over the estimated economic or legal
life, whichever is shorter, while the history of the Group has been to amortize product
rights over estimated useful lives of five to twenty years. The useful lives assigned to
acquired product rights are based on the maturity of the products and the estimated
economic benefit that such product rights can provide. Marketing rights are amortized
over their useful lives commencing in the year in which the rights first generate sales.
9.
Intangible asset movements
Goodwill
Product and marketing rights
Trademarks
Software
Other intangibles
Totals
2002 2001
(in CHF millions)
Cost, January 1
2,736 4,222 614 85
Consolidation changes
1
-(11)
Additions
937 51
13
5
65
Disposals
(7)
(6)
(6)
(6)
(17)
Translation effects
(399) (330) (95)
(9)
December 31 3,267 3,938 515 124 780
Accumulated amortization
January 1
(442) (577) (132) (62)
Consolidation charges
(20) (50)
Amortization charge (141) (286) (41)
Disposals
3
2
6
6
Impairment charge
(369) (102) (18)
Translation effects
94
53
25
December 31 (875) (960) (161) (109)
Net book value—December 31
2,392 2,978 354 15
431
333
49
1,071
(42)
(58)
8,624
7,990 6,508
457 496 752
696
(42)
(891)
76
7,990
(229)
(1)
(16)
26
(1,442) (678)
(42) (82) (195) (16)
(67) (551) (564)
43
45
(6)
(495) (216)
5
9
186
(13)
(349) (2,454) (1,442)
6,170 6,548
The principal additions in both years were goodwill on acquisition and in 2001
pitavastatin marketing rights.
In 2002, goodwill impairment charges were recorded of CHF 369 million mainly related
to the Pharmaceuticals division research and biotechnology activities of Genetic
Therapy Inc., Systemix Inc., Imutran Ltd., due to changes in the research and
development strategy, and relating to the Medical Nutrition and OTC business units.
The majority of the product and marketing rights impairment related to a CHF 80
million charge to the pitavastatin rights (2001: CHF 216 million).
Bayer Aktingesellschaft
Year ended December 31, 2002
[18] Intangible assets
Acquired intangible assets other than goodwill are recognized at cost and amortized by
the straight-line method over a period of four to fifteen years, depending on their
estimated useful lives. Write-downs are made for impairment losses. Assets are written
back if the reasons for previous years’ write-downs no longer apply.
Goodwill, including that resulting from capital consolidation, is capitalized in
accordance with IAS 22 (Business Combinations) and amortized on a straight-line basis
over a maximum estimated useful life of twenty years. The value of goodwill is
reassessed regularly based on impairment indicators and written down if necessary. In
compliance with IAS 36 (Impairment of Assets), such write-downs of goodwill are
measured by comparison to the discounted cash flows expected to be generated by the
assets to which the goodwill can be ascribed.
Self-created intangible assets generally are not capitalized.
Certain development costs relating to the application development stage of internally
developed software are capitalized in the Group balance sheet. These costs are
amortized over their useful life from the date they are placed in service.
Changes in intangible assets in 2002 were as follows:
Acquired concessions, industrial property rights, similar rights and assets, and
licenses thereunder
Acquired goodwill
Advance payments
Total
(€ million)
Gross carrying amounts, Dec. 31, 2001
5,240 1,399 42
Exchange differences (529) (163) (4)
(696)
Changes in scope of consolidation 2
7
-9
Acquisitions 3,057 2,267 -5,324
Capital expenditures 363 -72
435
Retirements (249) (204) (13) (466)
Transfers
39
-- (39)
-Gross carrying amounts, Dec. 31, 2002
7,923 3,306 58
Accumulated amortization and write-downs, Dec. 31, 2001
1,243
424
6,681
11,287
-1,667
Exchange differences (149) (43) -(192)
Changes in scope of consolidation ----Amortization and write-downs in 2002
1,058 205 -of which write-downs (249) (11) (--)
(260)
Write-backs ----Retirements (186) (144) -(330)
Transfers
--- --Accumulated amortization and write-downs, Dec. 31, 2002
1,966
442
-2,408
Net carrying amounts, Dec. 31, 2002
5,957 2,864 58
Net carrying amounts, Dec. 31, 2001
3,997 975 42
1,263
8,879
5,014
The exchange differences are the differences between the carrying amounts at the
beginning and the end of the year that result from translating foreign companies’ figures
at the respective different exchange rates and changes in their assets during the year at
the average rate for the year.
In 2002, as required by the newly implemented SFAS 142, the Group ceased
amortization of its goodwill recorded under IAS, its indefinite-lived intangible asset, the
Bayer “Cross” and the pre-1995 goodwill recognized for US GAAP purposes. The
adjustment reverses the amortization recorded under IAS for the Group’s IAS goodwill
of €11 million.
In-process research and development
IAS does not consider that in-process research and development (IPR&D) is an
intangible asset that can be separated from goodwill. Under US GAAP it is considered
to be a separate asset that needs to be written off immediately following an acquisition
as the feasibility of the acquired research and development has not been fully tested and
the technology has no alternative future use.
During 2002, IPR&D has been identified for US GAAP purposes in connection with the
Aventis CropScience and Visible Genetics acquisitions. Fair value determinations were
used to establish €133 million of IPR&D for both acquisitions, which was expensed
immediately. The independent appraisers used a discounted cash flow approach and
relied upon information provided by Group management. The discounted cash flow
approach uses the expected future net cash flows, discounted to their present value, to
determine an asset’s current fair value.
As a whole, the income booked for the reversal of the amortization of IPR&D recorded
under IAS as a component of other operating expense and selling expense amounted to
€5 million in 2002.